Equity markets shook off a rapid -12% correction in the technology sector to finish higher for the third quarter while falling inflation and rising unemployment led the Federal Reserve to cut interest rates for the first time since March 2020. ⁽¹⁾

The Federal Reserve’s aggressive September rate cut of 0.50% signaled a rising concern over the jobs market and a pronounced shift of focus away from the fight against inflation. Although the U.S. unemployment rate remains historically low, recent reports revealed a cooling job market. A decline in leading indicators such as job openings and employee quit rates historically precede job losses, and the Fed must carefully manage their dual mandate to achieve a soft landing for the U.S. economy. There are two more Federal Reserve Board meetings in 2024, and at the end of the third quarter markets anticipated at least two additional 0.25% rate cuts. It remains to be seen if expectations will align with reality.

From July 12th to August 5th, the tech-heavy NASDAQ index fell -12%, representing its largest decline since 2022. ⁽¹⁾ A disappointing jobs report, underwhelming tech company earnings, and the unwind of an obscure Japanese Yen carry trade combined to spark the selloff. However, not all sectors of the stock market experienced the same volatility during the quarter. “Value” sectors such as utilities, financials, and consumer staples outperformed growth sectors such as technology during the third quarter with less volatility. Value stocks returned 9% during the period while growth stocks returned 3.6%. ⁽¹⁾ The bond market also returned to form during the equity market selloff, providing a hedge against the market’s volatility. When the NASDAQ fell -12%, the bond market rallied +2.2% as investors fled to safer bond investments.

JFG Outlook

When assessing the intermediate outlook for markets, investors must consider the potential outcomes of the 2024 US elections. The focus of media coverage centers on the presidential election, but the results in the U.S. Senate and the House of Representatives are just as consequential for economic policies impacting Americans. For example, the upcoming sunset of the Tax Cuts and Jobs Act of 2017 (“TCJA”) is arguably the most important vote in 2025. Both political parties have indicated they intend to extend the TCJA in some form, which is a positive for most Americans. However, if Congress does decide to keep the tax cuts in place, at some point in the future they must address the ballooning Federal deficit caused by spending through the pandemic and beyond. A compromise on the budget at this stage seems like a long shot, but these basic revenue and expense dynamics of the U.S. government must be addressed eventually.

While we are no longer pounding the table on bonds, the fixed-income market should still provide ballast to portfolios and a hedge against rising recession risk. When we published our Q3 2022 Market Commentary, “Bond are Back”, bonds had their highest interest rates in nearly 15 years, and inflation showed signs of rolling over. Since then, the bond market has returned an above-average 12.2% in just two years. For comparison, during the ultra-low-interest rate environment from 2012 to 2018, the bond market returned an aggregate 15% over that entire seven-year period. ⁽¹⁾

We probably sound like a broken record, but the stock market remains expensive as it approaches 2021 valuation levels. ⁽²⁾ So, while we believe it is important to Stay Invested for the Unexpected (potential stock market rallies), we are currently being selective when making new equity investments. Technology stocks and artificial intelligence get a lot of the headlines on CNBC. Yet surprisingly, slow and steady utility stocks are the top-performing sector in the stock market this year as the rally has broadened out. 

The 2024 election cycle and frothy stock valuations may create some lightning rod “hot takes” to stir up investors’ emotions, if we choose to listen.

Sources

1. FactSet
2. JP Morgan’s Guide to the Markets